How Real Is the Plano Real: Controversy over the Thrust of Economic Reform

Montero, Alfred, Hemisphere

On July 1, 1996, the Plano Real (Real Plan), Brazil's most watched, ongoing national event, turned two years old. Fernando Henrique Cardoso depended upon the plan's initial success in reducing Brazil's chronic mega-inflation to carry him to the Brazilian presidency in 1994. Three years later, the entire country is still monitoring monthly inflation rates and trade balance figures with bated breath to see if the plan will continue to deliver on Cardoso's campaign promises of low inflation and stable growth. Yet skepticism has been voiced in the business community and among international observers regarding the plan's emphasis on the appreciation of the national currency and the inability of congress and the presidency to push forward the much-needed constitutional reforms. The plan's longterm success cannot be assured without these reforms.

In mid-1994, Cardoso's plan was launched with the creation of a new currency, the Real, with a value anchored to the dollar. Unlike the monetary anchor in Argentina that strictly fixes the national currency to the dollar; the Real was allowed to float within "bands" established by the central bank. Similar to the European Monetary System's method of floating national currencies within "bands" linked to the Deutschemark, the viability of the Real has depended upon the stability of its value against the dollar. By buying dollars when the currency was negotiated at a low rate to the Real and selling when the rate was slightly higher, the central bank floated the value of the Real between high and low values, a tactic that guarded against sudden devaluations but nevertheless allowed the new currency to gradually devalue. Meanwhile, the central bank was periodically moving the "bands" within which the Real floated to the dollar. At the beginning of the plan, the Real traded at $1.20, but by mid-1996, the Real traded at $.98.

During its first few months, the Real Plan was a resounding success that assured the election of Cardoso as president in late 1994--without the need for a run-off. Annual rates of inflation fell from 11,161 percent during the pre-Real days to 24 percent in 1995 and an estimated 12-15 percent in 1996, the lowest Brazilian inflation rates since the 7 percent figure recorded in 1957. And, more importantly, the plan put an end to the inflationary expectations that in the past drove rates spiraling upwards. The slight increases in the monthly inflation rates of September and October 1994 generated widespread talk of the Real Plan's premature failure, but such expectations quickly subsided as monthly inflation rates continued on a stable, low trajectory. Presently, most Brazilian businesses work with nominal figures uncorrected for the expected rate of inflation; indexation of salaries for inflation is being phased out.

The success of the Real Plan, however, has not come cheaply to a country with a long history of failed stabilization plans. The "band" system kept the Real overvalued by at least 15-20 percent, although some international estimates suggest an overvaluation in the neighborhood of 30-40 percent. The price of keeping the Real stable at these levels required the expansion of large foreign dollar reserves, a task made more difficult by periodic trade deficits. The overvalued Real reduced the competitiveness of exports and put an end to several years of large annual trade surpluses. And, more importantly, the constitutional and fiscal reforms necessary for consolidating macroeconomic stability--privatization, tax reform, reducing the size of the public payroll, among others--were either delayed or implemented at a snail's pace.

"WE ARE NOT MEXICO!"

The dangers of an overvalued Real were made clear shortly after the December 1994 maxi-devaluation crisis in Mexico when a combination of large trade deficits and low dollar reserves left Ernesto Zedillo's government unable to prevent the dumping of $10 billion of short-term peso bonds by foreign speculators following an announced devaluation of the currency. …

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